Is Pay-Per-Use for Broadband Inevitable?

Ed.: This is the first of a two-part post. The second post will appear on Sunday.

Exactly 20 years ago this month, Tim Berners-Lee invented the browser, HTML, and the World Wide Web, but things really took off six years later when America Online switched from pay-by-the minute dial-up to unlimited flat-rate plans, causing usage per sub to more than triple (PDF). Recently, however, wire-line and wireless providers are circling back, either trialing or instituting tiered or pay-per-use pricing, and in the world of cloud computing, pay-per-use is touted as a major benefit. Pricing plans may seem like an arcane topic for marketing professionals, but are driving fundamental questions regarding global capital expenditures and the sustainability of the current content and network ecosystem. If pay-per-use prevails, what are the implications on industry structure and new business opportunities?

For the record, I like unlimited Internet access just as much as anyone else. However, such plans appear to be on their way out, and here’s why. As I’ve explored in ”The Market for Melons” (PDF), pay-per-use is not an evil plot by greedy robber barons, but a natural outcome of independent, rational consumer choice. Consider a town with an all-you-can-eat (flat rate) buffet and an a la carte (pay-per-use) restaurant. Smart shoppers on diets will save money by patronizing the a la carte restaurant, whereas heavy eaters will save money by visiting the buffet. As patrons switch, the average consumption of the buffet will increase, driving price increases for the luncheon special, causing even more users to switch to pay-per-use.

Bottom line: it is not the proprietors driving this dynamic, but the customers themselves acting out of pure, rational self-interest—light users, by deciding not to subsidize the heavy ones, foster the vitality of the pay-per-use model. As the spread in bandwidth consumption increases between frequent digital movie streamers or videoconferencing users and lightweight occasional emailers, rational light users will want to migrate to pay-per-use. Of course, people aren’t always rational, and consumers often prefer to overpay for flat-rate (PDF) rather than save money but risk bill shock.

Under conditions where buyers are coldly rational, active decision-makers, consumption levels are dispersed, prices are a non-trivial portion of income, and the industry is highly competitive, pay-per-use will tend to dominate. When behavioral economics come into play and emotions and cognitive biases are taken into account, switching costs are high, there are no meaningful differences in consumption levels among consumers, and/or there is a single dominant player, flat-rate may prevail. And, there may be a pendulum effect as marketers attempt to differentiate their offers from prevailing practices.

A large number of business models from the “over-the-top” providers of content, applications, and services have been predicated on zero marginal cost to consumers for data usage. It’s not only an access issue; consider the current Comcast / Level 3 disagreement regarding payment for core backbone bandwidth. What might happen if pricing plans, instead of being “unlimited,” become increasingly granular and usage-sensitive? In tomorrow’s post, I’ll predict possible implications, ranging from cultural changes, application and architecture shifts, and industry ecosystem and business model transformation.